Thursday, January 10, 2013

Still enjoying the magic - ECB keeps rates on hold

As expected, the ECB left interest rates on hold in its first meeting of the year. The ECB is obviously still enjoying the magic of its OMT announcement, knowing that the fate of the recovery is now in the hands of governments and the private sector.

The ECB’s macro-economic assessment was almost a verbatim copy of the December assessment. The ECB still expects a very gradual recovery in the course of the year and seems to take comfort from the recent improvement in confidence indicators and financial markets. ECB president Mario Draghi pointed out that the most encouraging signal was coming from financial markets. Lower bond yields, higher stock prices, record-low volatility, strong capital inflows into the Eurozone, a halt of deposit flight in peripheral countries and a reduction of the ECB’s balance sheet were on Draghi’s long list of illustrated market improvements. However, Draghi did not become overly enthusiastic, stressing that up to now there were no signs of an improvement of the real economy and that any recovery in the course of the year would be subdued. As a consequence, the risks to the ECB’s macro-economic analysis remained unchanged: risks to growth remained to the downside, while risks to price stability remained balanced.

According to Draghi’s comments, the call for a rate cut within the Governing Council has all but disappeared. In our view, another rate cut is therefore finally off the table. unless a renewed worsening of the economy would emerge.

Even if Draghi said that it was too early to declare victory and hesitated to adopt the latest improvement as the ECB’s success, today’s press conference had some hidden self-praise. The explicit reference to “reduced fragmentation” of financial markets as potential source of the expected recovery and the fact that “uncertainties about the resolution of sovereign debt and governance issues” disappeared as a risk to growth was a clear backslapper, at least for insiders.

It is obvious that the ECB enjoys its role as the successful crisis manager who averted an imminent break-up of the monetary union. The pure announcement effect of the ECB’s OMT programme has been so powerful in bringing down sovereign spreads and improving market conditions that the activation of the programme might never be needed.

Looking ahead, however, the ECB’s role as Eurozone crisis fighter might become less glamorous than in 2012. Simply because the ECB has run out of options to stimulate the real economy. Using the last ammunition left, a rate cut, would hardly have any impact on the real economy. It is hard to see that the ECB could invent anything similar to an OMT for the real economy. This means that while enjoying the magic, the ECB will secretly keep its fingers crossed, hoping that better financial market conditions and structural reforms eventually really lead to an economic recovery.